July 24, 2014 - From the August, 2014 issue

The Demise of TIF-Funded Redevelopment in California

George Lefcoe, a professor of law at USC Gould, and Charles W. Swenson, a professor of accounting at USC Leventhal, take an in-depth look at the rise and fall of CRAs in California—the first state to embrace tax increment financing for redevelopment, and the first to abandon it. In the process, they unpack assumptions about TIF that prove problematic. TPR prints the following excerpt with permission of the authors. The full paper will appear in the National Tax Journal’s fall issue (SSRN 2428347). Prior pieces in TPR’s series on TIF can be found here and here.


George Lefcoe

"The demise of TIF in California is a cautionary tale about property tax revenues, not necessarily a rejection of all redevelopment efforts." —George Lefcoe and Charles W. Swenson

TAX INCREMENT FINANCING (TIF) IN THE EARLY YEARS OF REDEVELOPMENT IN CALIFORNIA

Tax increment financing (TIF) refers to a process of paying for redevelopment activity with anticipated increased property tax revenues from the redevelopment project itself. TIF gained political acceptability in the early 1950s in California because it required no new taxes. TIF proceeds were drawn entirely from higher property taxes assessed upon future owners of property within redevelopment project area boundaries.

California redevelopment was first authorized in 1945 when the state legislature enabled cities and counties to establish redevelopment agencies (RDAs). The objective of early redevelopment was to halt the middle class exodus from central cities that had accelerated after World War II. The idea of funding redevelopment with tax increments came later.

RDAs assembled underutilized sites, cleared them of older buildings, and installed the infrastructure needed to support what real estate appraisers would call “higher and better” uses at these urban locations. This land would then be sold at fair market value to private developers prepared to construct projects consistent with the locality’s renewal plans and aspirations. The idea was to make urban sites available for private redevelopment at prices comparable to those of “green field” sites in rapidly growing suburbs. To facilitate this, government subsidies covered the gap between what the land had cost to be put into immediately buildable condition and what developers were willing to pay for it (Slayton, 1960). From 1949 through 1974, the federal government provided approximately $53 billion (2009 dollars) in grants to cities for housing and urban redevelopment projects (Collins, 2011). Federal grants were contingent on local governments raising matching shares, and California led the way in utilizing TIF for this purpose. By leveraging TIF revenues with much larger federal grants, huge increases in assessed property values could be anticipated in core downtown areas where high density office and commercial projects would displace low density, low income dilapidated housing.

For decades, leading policy makers disregarded the social costs of this dislocation. But changes were eventually made, on the federal, state, and local level. The federal government enacted a uniform relocation law. On the state and local level, California mandated that 20 percent of all tax increment funds be set aside to preserve the supply of affordable housing, the redevelopment law imposed various constraints on the condemnation of homes, and RDAs became more sensitive to the issues of displacement.

Other taxing entities went along after seeing how rejuvenating center cities with capital-intensive redevelopment would eventually reverse the declining fortunes of center cities and significantly raise property tax revenues. The other taxing entities would continue to receive their pre-redevelopment levels of property tax revenues. They would only be deprived of the “increment” which was defined as the increase in the tax base after redevelopment project boundaries had been set in place.

RDAs could raise capital by issuing tax allocation bonds (TAB). They did not have to borrow money from the sponsoring local government to come up a lump sum matching share. Bond investors would be repaid entirely from the anticipated tax increments…

PROPOSITION 13 IMPLICATIONS FOR REDEVELOPMENT

On June 6, 1978, California voters by a two-to-one margin approved Proposition 13 (Cal-Tax Research, 1993). This measure added a provision to the California Constitution that placed significant limitations on property taxes…

Redevelopment in California would never have become so widespread but for Proposition 13. Desperate for replacement revenues, cities (and a few counties) saw an opportunity to fill their depleted property tax coffers by culling property taxes from other taxing entities (Fulton and Shigley, 2005). In the 1960s and 1970s, as the Legislative Analyst observed, few communities established RDAs, and project areas were compact—usually 10 to 100 acres (Legislative Analyst’s Office, 2011, p.1). Under the complicated tax allocation formulas the state legislature put in place, city shares of the property tax ranged from 5 percent to 20 percent with most of them ranging between 10 and 15 percent.

Utilizing TIF, a city redevelopment agency could multiply its share of the total property tax increment. Many cities formed RDAs for the first time, and RDAs, old and new, expanded boundaries. For instance, the city of Los Angeles’ signature redevelopment project, Bunker Hill, had contained 133 acres. After Prop 13, virtually all of downtown Los Angeles was placed in one of nine redevelopment project areas, a total of 5474.9 acres within redevelopment project boundaries. In reality, redevelopment project areas had become little more than TIF districts…

THE CASE AGAINST DRAINING TAX INCREMENTS FROM TAXING AGENCIES OTHER THAN THE SPONSORING CITY OR COUNTY

The conventional rationale for TIF is that schools, counties and special districts would not lose any property tax revenue. They continue to receive property taxes based on the assessed values of properties within their domains in the year before redevelopment. In time, a pot of gold awaits the other taxing entities at the end of the redevelopment rainbow when all agency debts are repaid. At that point, the other taxing entities start to receive the tax increment bonanza that redevelopment made possible.

These rationales are seriously flawed. First, they disregard the ex-ante risk-reward imbalance that cities sponsoring redevelopment impose on other taxing entities. Second, they presume that but for redevelopment there would have been no growth within designated redevelopment project areas. Third, redevelopment projects seldom create new demand. They simply shift demand from other areas into redevelopment project areas. The larger the boundary of the other taxing entity, the more likely it will be a net loser of property, sales or hotel transit occupancy taxes due to redevelopment “cannibalization.” Fourth, nothing prevents cities from using TIF to subsidize the sorts of local “public goods” like parks, libraries, street and sidewalk improvements that were traditionally financed from local general funds, general obligation bonds, or special assessments. Fifth, TIF encourages RDAs to subsidize projects that will yield higher property taxes such as high rise, glass curtain wall condos or greater sales tax proceeds such as auto malls and regional shopping centers, even at the cost of displacing lower and working class populations. 

A. The Risk-Reward Imbalance of TIF Funded Redevelopment for Other Taxing Entities

There is a striking asymmetry in the risk-reward trade-off for other taxing entities. If the redevelopment project is a staggering financial failure, it could even push property tax revenues below pre-redevelopment levels, and the other taxing agencies will take the hit.

If the redevelopment project proves to be an enormous financial success, the other taxing entities will see little of the bonanza until all the redevelopment debt is fully repaid. To defer termination, RDAs and their sponsoring cities repeatedly extend and amend redevelopment plans to avoid ever having to turn off their TIF spigots.

This imbalance is exacerbated because decision-making is vested solely and exclusively in the RDA and its sponsoring city or county. The other taxing agencies have no right to decide whether they want to participate in a proposed redevelopment project. 

B. In Calculating Tax Increments RDAs Include Growth That Would Have Occurred Without Them

Buoyant growth throughout the state enabled redevelopment projects to prosper. Between the mid-1970s and the 1990s recession, “California's economy generally outperformed the nation's, often by considerable margins” (Legislative Analyst’s Office, 1995, p. 5). In the pre-Proposition 13 universe school districts would have had access to the property tax revenues from the general rise in property values statewide.

A study by the California Redevelopment Association (CRA), typical of the poor quality of evaluation done by most economic development agencies, claimed that redevelopment had created 304,000 jobs statewide. California’s Legislative Analyst, answering the question “Should California End Redevelopment?” faulted the CRA’s study for failing to address this crucial question: but for the redevelopment agency’s efforts, would the project have been built anyway, either within the project area or elsewhere within the county or state? (Lefcoe, 2012, p. 779).

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In contrast to the CRA study, two empirical studies have examined the economic impacts of the California RDA program in light of the “but for” issue. Dardia (1998) provided a detailed empirical evaluation of RDAs from 1993–1996. Examining 38 project areas in three counties (Los Angeles, San Mateo, and San Bernardino), he compared actual property tax valuation changes for Census tracts which contained RDAs, to matched tracts in the same cities which did not have RDAs. Two thirds grew more rapidly, but one third grew less. More importantly, he concluded that only four of the 38 project areas grew fast enough to be considered self-financing.

Swenson (2014) examined the impact of California RDA policies on RDAs at the census tract level, digitizing individual RDA maps to create precise areas of RDAs and also of their adjoining Census tracts. Using related economic data from the Census for 1980, 1990, and 2000 to compare the economic performance of RDAs versus immediately adjacent areas, and to the rest of California, he found that in the 1990s there was little measurable impact of RDAs on RDA area employment, poverty rates, family incomes, rental vacancy rates, and average residential rental rates. He also found that there was also little measurable business growth in such areas during the 2000-2009 decade in terms of job creation or business revenues.

C. Cannibalization

This is a marketing term that refers to competing products or firms draining market share from each other. New development increases the supply of space but does little to increase long-term aggregate demand for space, goods and services (Ingraham, Singer, and Thibodeau, 2005). The mantra “build it and they will come” rarely works except to shift already existing demand from one location to another.

Inter-municipal competition based on tax breaks or infrastructure subsidies to attract new firms is short sighted. Competing cities could easily be tempted to out-spend each other to attract retail outlets that yield disappointing sales and property tax results, engaging in a “race-to-the bottom” until their tax bases are drained dry (Cassell and Turner, 2010).

Frisco, Texas, a prosperous, fast growing suburban city, gave millions of dollars to attract an IKEA. Tax incentives don’t increase the regional demand for furniture; at most they just shift the location of furniture spending, or maybe just the showrooms where consumers look at furniture before buying it online. Why do officials in places like Frisco, Texas, assume that adjoining cities, in this case, Dallas, will not eventually come up with an even more attractive subsidy or incentive for an IKEA rival?

While state legislatures are in a position to end TIF-based bidding wars among localities for retail development, very few states have done so (Lefcoe, 2011).

Unless the boundaries of other taxing entities — such as schools, special districts or counties — are coterminous with the boundaries of the city sponsoring the redevelopment project, there could be net loses of property, sales or hotel occupancy taxes. Many California counties vigorously opposed city-sponsored redevelopment because they recognized that most if not all of the TIF-absorbing development would occur anyway somewhere within the county. This is not only true of retail. Returning to the Bunker Hill example, most of the downtown Los Angeles office tenants would have located somewhere within Los Angeles County.

Similarly, when the other taxing entity is the state government itself, the chances are even smaller that a particular TIF-funded redevelopment project would have left California “but for” that city’s redevelopment efforts. This is another reason why the state of California could be understandably more wary than a county, special district, or school district of the net tax impacts of TIF-funded redevelopment on its revenues. 

D. Strategies for Using TIF to Fund Local Public Amenities That Do Not Increase Property Values

A city anticipating ever rising property values can use TIF to finance traditional local public uses instead of drawing on the sponsoring city’s or county’s general funds, general obligation bonds, or special assessment revenues. Typical public uses would include parks, libraries, parking structures, street and sidewalk landscaping improvements. This is unfair to county taxpayers who reside far from the TIF exploitive city and hence will never use the public amenities their tax dollars inadvertently helped to finance. This practice also betrays the central promise inherent in redevelopment of stimulating new private development that will generate tax increments. Because public uses like parks and libraries are tax-exempt, such amenities are not likely to result in valuation dividends sufficient to compensate for the TIF foregone by other taxing entities. 

E. TIF Based Redevelopment Is Structurally Unsuited to Assisting Low and Moderate Income Residents

Redevelopment of blighted areas already ripe for gentrification produces big property tax increments (Lefcoe, 2008). Programs meant to encourage new development in low income neighborhoods without destroying them need to be funded in ways other than or in addition to TIF. A good example of this can be found in the New Markets Tax Credit (NMTC). Although it has received mixed results so far, its generous tax credits are intended to spur equity investment in low-income neighborhoods (Theodos, 2013). Eligibility is determined by federal guidelines that define low-income areas, not by local governments or their private partners seeking tax credits. “The NMTC Program attracts investment capital to low-income communities by permitting individual and corporate investors to receive a tax credit against their Federal income tax return in exchange for making equity investments in specialized financial institutions called Community Development Entities (CDEs).”

Hence, investors can achieve acceptable rates of return without gentrification, and the increased rents and sales prices it spurs.

THE END GAME: AB X1-26 AND AB X1 27

The state legislature dissolved RDAs through a series of amendments to the California Health and Safety Code in legislation known as AB 26 (also known as X1 26). To secure the support of some lawmakers friendly to redevelopment, the legislature offered a “pay to stay” option. For a steep price, dissolution was avoidable under a companion statute known as AB 27…

The fiscal purpose for dissolving RDAs was to re-direct tax increment funds from redevelopment to counties, education and special districts…

CONCLUSIONS

The demise of TIF in California is a cautionary tale about property tax revenues, not necessarily a rejection of all redevelopment efforts. For reasons unique to California’s property tax regime, many cities (and a few counties) used TIF-funded redevelopment so aggressively that they diverted significant property tax revenues from other taxing entities, and particularly from the State, which bears ultimate responsibility for financing public education.

When RDAs took to the ballot box to prevent the state from re-capturing those revenues, Governor Brown said “enough” and dissolved them. RDAs were drawing funds from other taxing agencies without their consent in order to subsidize sales tax-generators like shopping centers and auto malls, and TOT-generators like hotels. At first it may seem odd that sponsoring cities and counties had no interest in preserving their 427 RDAs unless they could retain the tax increments from other taxing entities; however, the explanation is simple. Any California city or county has virtually limitless ways to achieve the objectives once accomplished through redevelopment if it is only spending its own tax revenues. Cities and counties can enter these arrangements free of the costs and constraints of redevelopment law which had been imposed mostly to curb the use of other taxing entities’ shares of the tax increment, a raison d’etre now as much a matter of history as California redevelopment itself.

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© 2014 The Planning Report | David Abel, Publisher, ABL, Inc.